Stock market projections
Return expectations for the stock and bond markets and sales, cost, and profit projections for industries and nearly all companies necessarily embody economic assumptions. It is the exceptional case for which this is not true. Economic forecasts need to be considered in terms of the individual analysts requirements and must be viewed from the standpoint of both their usage and their preparation. Economic assumptions may be explicit or implicit. For an investment organization, explicit forecasts are necessary for effective communication throughout the organization. Individual investors may assimilate from review of a series if forecasts an implicit and intuitive set that are satisfactory for their purposes. In all instances, investors using such forecasts should have clearly in mind the time span for which they want projections and the key cyclical or secular assumptions underlying the forecasts used.
Economic Forecasts in Perspective:
Economic forecasts provide essential underpinning for stock and bond market, industry, and company projections.
The outlook for stock and bond markets depends on the outlook for such basic economic factors as:
The growth rate for real GNP and GNP in current dollars.
The supply of funds coming principally from business and personal savings, including pension funds.
The demand for funds arising from financing expenditures by consumers, business, and governments.
The inflation rate and anticipated inflationary pressures.
Corporate profits.
Similarly, the outlook for industries and companies depends on the outlook for those economic factors that affect demand for their products and the cost of labor, material, and capital. The accuracy and consistency of analysts projections for industry and company sales, expenses, and earnings lie in the closer knitting of economic and security analysis. This requires establishing internally consistent economic projections on which all other forecasts should depend.
Large organizations with in-house economists develop their own forecasts. In the process, they examine the projections of others, such as brokerage houses and banks, and frequently subscribe to one or more forecasting services, such as Data Resources, Inc., Chase Econometrics, and the Wharton Econometric Model. Computer access to these models allows for testing of alternative assumptions and otherwise modifying the standard projections produced by the forecasting services. Small investment organizations and individual investors typically rely on external forecasts as provided by brokerage houses and subscription services as mentioned above. These smaller organizations are less likely to have computer access to an econometric model and will rely primarily on the memoranda and reports issued at regular intervals, quarterly or more frequently.
Cyclical and Secular Forecasts:
Investment decisions should be based on longer term as well as near-term projections. Indeed, institutional investment decisions are increasingly made on a longer-term basis. On the one hand, investment theory tells us that the worth of a common stock is the present value of its entire future earnings or dividend stream. Therefore, explicit long-term projections are impractical.
On the other hand, the earning power or dividend paying capacity of an enterprise and thus the central tendency in its price cannot be judged adequately on the basis of a one- or two-year outlook. The normal current price level, longer term growth, stability of earnings, and the dividend payout ratio of the typical company cannot be effectively appraised in terms of what may happen in the next year. Likewise, it would be purely coincidental if the future growth rate of industries, the stock market, or the total economy were meaningfully indicated by the near term outlook. Undue emphasis on the near term can produce distorted investment decisions. The conceptual differences between near term cyclical predictions and longer term secular projections are as pronounced as the differences in the projection spans. These differences must be understood because they involve substantially different appraisals of the future.
Near Term Forecasts:
In general, near term projections comprise the next four to eight quarters and are typically designated as forecasts by business economists. These projections represent definitive estimates of what will happen in a given time frame. They are predictions of the specific level and nature of economic activity on a quarter by quarter basis, and thus they map out the cyclical path that the economy is expected to follow.
Quarterly Demand Forecasts:
Near-term forecasts are primarily demand forecasts. The level of business activity in the short run is determined more by changes in income and expenditures than by changes in capacity. Accordingly, although careful consideration must be given to the relationship of demand to the nations existing output capacity, demand rather than capacity can change significantly over the near term.
Economic Models:
These models are derived from extensive systematic analysis of the past behavior of key economic variables and delineate in general terms the behavior patterns and inter relationships within the economic system of households, businesses, governments, and foreigners, the principal classes of economic units.
Conditional and Interdisciplinary:
Longer-term projections are much more conditional than near-term predictions. They are affected substantially more by noneconomic factors. Over a span of years, social, political, technological, and international forces can critically affect both the demand for goods and services and the ability to produce them. Accordingly, effective longer-term economic forecasts are interdisciplinary undertakings to a surprising extent.
Importance of Longer-Term Projections:
The primary importance of these longer-term projections does not lie in the specific numbers generated, which principally represent orders of magnitude. Rather, it lies in the research findings and reasoning on which the numbers are based and in the benchmarks and relationships they establish. It would be coincidence if the projections were an exact anticipation of the future; nevertheless, explicit forecasts are necessary for the mental discipline, logic, and cross-checks required in drawing definitive conclusions.
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